An unlevered company operates in perfect markets and has a net operating income (EBIT) of $250,000. Assume that the required return on assets for firms in this industry is 12.5 percent. The firm issues $1 million worth of debt, with a required return of 5 percent, and uses the proceeds to repurchase outstanding stock.
a. What is the market value and required return of this firm's stock before the repurchase transaction?
b. What is the market value and required return of this firm's remaining stock after the repurchase transaction?